Your Client Received Notice of a Bankruptcy Filing. Now What?

The Bencher—September/October 2021

By Amelia Martin Adams, Esquire

It’s late afternoon and your phone rings. A client’s longtime customer filed bankruptcy, and the client needs advice about protecting its interests during the case. In this challenging economic climate, the likelihood that bankruptcy will impact the practice of “non-bankruptcy” lawyers is increasing. Bankruptcy cases—especially business cases—can come in like a lion and move extraordinarily quickly, so having a familiarity with the system before a case crosses your desk is invaluable. This article offers insights into steps counsel should consider after receiving an initial call from a creditor client concerned about a bankruptcy.

Step One: Familiarize Yourself with the U.S. Bankruptcy System.

The Courts. As with any new area of law, it is critical to understand the basic structure of the court before wading into deeper waters. U.S. bankruptcy judges preside over nearly all bankruptcy matters. By authorization in the U.S. Constitution, Congress gave U.S. district courts jurisdiction over all cases under, arising in, and related to the U.S. Bankruptcy Code. See U.S. Const., art. I, § 8, cl. 4; 28 U.S.C. § 1334. In practice, District Courts “refer” bankruptcy matters to the U.S. bankruptcy courts in their districts by enacting a local rule or entering a standing order. See 28 U.S.C. § 157(a). Although district courts may “withdraw the reference” of a matter “for cause shown,” that rarely occurs. See 28 U.S.C. § 157(d).

The Law. U.S. bankruptcy courts are guided primarily by the U.S. Bankruptcy Code, 11 U.S.C. §§ 101, et seq. (Bankruptcy Code), and accompanying Federal Rules of Bankruptcy Procedure (Bankruptcy Rules). Due to the myriad variations of assets, liabilities, and business interests that enter their courtrooms, bankruptcy judges are also well-versed in many other areas of federal and state law. To maintain consistency nationwide, the Judicial Conference of the United States publishes Official Bankruptcy Forms that must be used in all bankruptcy cases. See Fed. R. Bankr. P. 9009. The director of the Administrative Office of the U.S. Courts issues Director’s Bankruptcy Forms that local rules or general orders may require parties to use but otherwise exist for the parties’ convenience. All official forms and director’s forms are available at www.uscourts.gov/forms/bankruptcy-forms, and their instructions are helpful for first-time users and experienced practitioners alike.

The Local Norms. Many bankruptcy courts augment the Bankruptcy Code and Rules by enacting local rules and forms to codify procedural norms within their districts. See Fed. R. Bankr. P. 9029. A detailed administrative procedures manual governing the nuts and bolts of electronic filing is also common. See Fed. R. Bankr. P. 5005(a)(2)(A) (requiring electronic filing by counsel). Failing to comply with local procedures is an easy way to aggravate the judge and ensure that your motion will be denied. Counsel would be well-advised to review the court’s local rules and forms in their entirety at the outset of a new engagement and especially before filing a pleading.

The Case Types. Bankruptcy cases are named for the Bankruptcy Code Chapter that primarily governs the case, which is determined by debtor type, nature and amount of debts, and type of relief sought. For example, a Chapter 7 liquidation case is primarily governed by Chapter 7 of the Code. Consumer (non-business) debtors can seek relief under Chapter 7 liquidation, Chapter 11 reorganization, or Chapter 13 reorganization, depending on several variables, including, but not limited to, their ability to repay creditors. See 11 U.S.C. §§ 701-784, 1101-1195, 1301-1330. General business debtors can seek relief under Chapter 7 or 11. Chapter 7 allows for asset liquidation by a trustee, while Chapter 11 allows for a plan of reorganization (or sometimes liquidation) by the debtor. Chapter 12 is available to family farmers and fishermen and women. See 11 U.S.C. §§ 1201-1232. Municipalities may seek relief under Chapter 9. See 11 U.S.C. §§ 901-946. And, Chapter 15 is used in international insolvency cases. See 11 U.S.C. §§ 1501-1532. Chapters 1, 3, and 5 of the Code generally apply to all bankruptcy cases and provide standards for case administration.

The Players. Many of the same players are present in every bankruptcy case. The case begins with the filing of a bankruptcy petition, and the date on which the petition is filed is aptly called the petition date. The individual or entity that seeks bankruptcy relief is the debtor. Only in Chapter 11 cases, the debtor becomes a “debtor in possession” or “DIP” immediately upon filing, meaning that the debtor is responsible for administering the case. See 11 U.S.C. § 1107. You’ll hear DIP used frequently in Chapter 11, especially if the DIP seeks financing during the case through a DIP Loan. The trustee is also a frequent flyer. A case trustee is appointed at the outset of each Chapter 7, 12, and 13 case. See 11 U.S.C. §§ 704, 1202, 1302. Trustee appointments rarely occur in Chapter 11 cases, as the DIP manages the estate as a fiduciary. See 11 U.S.C. §§ 1104, 1107. A U.S. trustee (UST) supervises all bankruptcy cases on behalf of the U.S. Department of Justice. See 11 U.S.C. § 307. The Unsecured Creditors Committee, or “Committee,” is a common presence in large Chapter 11 cases and, where appointed, represents the interests of all unsecured creditors. See 11 U.S.C. § 1102. All of those entities are concerned with the bankruptcy estate, which is created upon the petition filing and broadly encompasses all of the debtor’s legal and equitable interests in property as of the petition date. See 11 U.S.C. § 541.

Step Two: Carefully Review the Bankruptcy Notice.

The notices of a bankruptcy filing are official bankruptcy forms, so counsel can become familiar with the format before a new case arises. See Off. Bankr. Forms B09A-I. The first page lists the debtor’s name, identifying number, and the petition date, which is used to calculate deadlines throughout the case. It also provides contact information for debtor’s counsel and the case trustee. Before filing any request for relief, counsel should consider contacting debtor’s counsel and, where applicable, the trustee, to attempt to resolve the matter consensually. Bankruptcy courts are pragmatic and appreciate counsel’s efforts to cooperate before involving the bench.

The second page of the notice lists the date and location of the meeting of creditors that a trustee conducts during the first weeks of the case. Section 341 of the Code requires that meeting, which is why practitioners refer to it as a “341 meeting.” The trustee will question the debtor about assets and liabilities and then open the meeting for questions by creditors. The 341 meeting is not a substitute for a deposition or a Bankruptcy Rule 2004 examination but can be a useful tool for gathering basic information in the early stages of a case. Counsel representing secured lenders or equipment lessors may find it especially helpful to ask the debtor about the location, condition, and security of their collateral or leased property.

Depending on the case type, counsel should further review the notice for deadlines for filing a proof of claim, objecting to dischargeability of a debt, and objecting to exemptions. In a Chapter 13, counsel also should note the deadline for objecting to confirmation of the debtor’s repayment plan and the confirmation hearing date. When in doubt, schedule all deadlines on your calendar and consult with experienced counsel before those dates approach to ensure that your client’s rights are preserved.

Step Three: Understand and Respect the Automatic Stay.

The “automatic stay” is one of the strongest injunctions in American law. Codified in Section 362 of the Code, the stay arises the moment a debtor files a bankruptcy petition. With limited exceptions, it stays most actions a creditor could take against a debtor, including, but not limited to, commencing or continuing a proceeding against the debtor that could have been commenced pre-bankruptcy, enforcing a pre-bankruptcy judgment against the debtor or estate property, and any act to obtain possession of or exercise control over estate property. See 11 U.S.C. § 362(a).

If you take away only one thing from this article, let it be that your client must respect the automatic stay. Unless it is abundantly clear that one of the exceptions in Section 362(b) applies, it is safest to assume that the stay precludes your creditor client from taking any action against the debtor during bankruptcy, unless and until your client obtains a bankruptcy court order granting it relief from the stay under Section 362(d). Stay violation damages are steep, and willful violations risk a court order requiring the violator to pay the debtor actual damages, including attorneys’ fees, and punitive damages. See 11 U.S.C. § 362(k).

Step Four: Consider the Need for Experienced Bankruptcy Counsel.

To appear in bankruptcy court, counsel must be admitted to the U.S. District Court in which the bankruptcy court sits or obtain pro hac vice admission for a particular case if he or she does not appear regularly in that court. Pro hac vice admission is relatively common in Chapter 11 cases and less so in others. Before seeking pro hac vice admission, review the court’s local rules to determine whether and to what extent local counsel is required.

Because the Bankruptcy Rules mandate electronic filing, admission is only half of the equation. Counsel also must obtain electronic filing credentials from the court before filing a pleading, which often requires completion of a training course. In some courts, local counsel must sign and file pleadings on behalf of pro hac vice counsel, even if primary counsel has electronic filing credentials.

While these procedural steps are not insurmountable, they do take time, and counsel must consider both the time and complexity factors before taking a new bankruptcy representation. Chapter 11 cases in particular move very quickly, with only a couple of days’ notice before the first-day hearing at which the DIP will seek a variety of complex relief to maintain operations during the initial weeks of the case. While some first-day relief is commonplace and regularly approved (e.g., paying wages and maintaining insurance), other requests for relief can spark controversy (e.g., DIP Loans secured by liens that “prime” existing liens and “critical vendor” payments). Consumer cases typically move a bit slower but still require relatively quick action.

Step Five: Calculate Your Client’s Claim and Gather Supporting Documents.

A clear understanding of your client’s pre-bankruptcy dealings with the debtor is crucial to protecting the client’s rights during a bankruptcy. Proofs of claim are required early in some cases and later in others. See Fed. R. Bankr. P. 3002(c) (filing deadline in Chapters 7, 12, 13); Fed. R. Civ. P. 3003(c) (filing deadline in Chapter 11). Regardless of when a proof of claim filing bar date deadline is set, in the early days of the case, counsel should request all documents evidencing the client’s right to payment from the debtor and ask the client pointed questions to understand the interests in play. The Code is full of specialized, complex provisions that govern different debtor-creditor relationships, and failing to adhere could result in a zero recovery for your client. Secured creditors, unsecured creditors, leaseholders, and contract parties alike all have unique rights and responsibilities. If your client’s pre-petition relationship with the debtor was adversarial, consider the need for a litigation hold to avoid future problems if your client becomes involved in litigation in the bankruptcy, either within a “contested matter” initiated by motion inside the bankruptcy case or a related civil lawsuit called an “adversary proceeding.”

Now, What? Weaving the Steps Together to Begin a New Representation.

Engaging in any new area of practice requires study. By acquainting yourself with the process and considering these initial steps, counsel can alleviate some of the uncertainty that accompanies first encounters with a bankruptcy representation. Due to its fast pace and intricate statutes, bankruptcy initially can be a bit overwhelming. But if you choose to pursue it regularly, I trust that you will find it to be a very interesting and rewarding area of practice.

Amelia Martin Adams, Esquire, is an attorney with the law firm of Stoll Keenon Ogden PLLC in Lexington, Kentucky.  She practices in the areas of business and consumer bankruptcy, financial restructuring, and civil litigation.  She is a Barrister member of the Central Kentucky American Inn of Court.